PART THREEINTRODUCTION TO BUSINESS

MODELING

WHAT DOES “VALUE PROPOSITION” MEAN TO YOU?

ASPECT DESCRIPTION

VALUED Customer will pay money to buy what you are selling because it addresses a real urgent & intense need/pain/opportunity

VALUABLE The # of customers willing to pay is sufficiently large to fund your company & your segmentation strategy gets you access to them effectively

VALID Your product works, is compliant as required, and has the right features

VALUNIQUE You have a sustainable & defensible competitive advantage and are competing on the right vectors of differentiation

VALUE CHAIN

You can deliver the product promises across the value chain and scale with growth

VALENCE You have a strongly-bonded team with all the right skills to pull this off

VALUATION Your cost and revenue models lead to profit and the profitpotential is attractive enough for shareholders and investors

BUSINESS MODELS CAN BE EXPRESSED AS A FORMULA

$ = REVENUE – COST

implementability,

sustainability, & exit

&

$ > $ from other

investments

COSTS BOIL DOWN TO 4Ps

COST = PEOPLE

+ PRODUCTION

+ PROMOTION

+ PLACE

PROFIT = (REVENUE – COST) I, S,E

COSTS TREES HELP FOCUS VARIABLES AND LEVERS

PROFIT = (REVENUE – COST) I, S,E

PEOPLE COST

# OF PEOPLE

COST PER PERSON

REDUCE HEADCOUNT

REDUCE SALARY

REDUCE OTHER COSTS

Automate functions

Support fewer process/product

Consolidate functions across silos

Increase productivity

Pay cuts

Replace expensive staff with cheaper

Grants & Subsidies

Reduce recruiting costs

Reduce benefits

Outsource

REVENUE IS MORE COMPLEX, BUT STILL DIVISIBLE

PROFIT = (REVENUE – COST) I, S, E

REVENUE =Rev stream 1

All revenue streams

(PRICE x VOL)

Revenue is slightly more complex than cost &

embodies more assumptions that you must justify!

We must still break out PRICE & VOLUME

separately.

∑

PRICE IS A BALANCING ACT

PROFIT = (REVENUE – COST) I, S, E& REVENUE = PRICE x VOLUME

Customer

Perceived

Value

Cost to

Produce

Range of

Prices

Customer

Perceived

Value

Cost to

Produce

Effect of

Competition

Customer

Perceived

Value

Cost to

Produce

Goal of

Competitive

Positioning

Customer

Perceived

Value

Cost to

Produce

Goal of

Branding &

PR Strategy

Customer

Perceived

Value

Cost to

Produce

Goal of

Operations

Strategy

VOLUME STARTS WITH SEGMENTATION STRATEGY

PROFIT = (REVENUE – COST) I, S, E& REVENUE = PRICE x VOLUME

Q: Why are whole markets not addressable by any single company.

• Real customer wants – who wants a generic product?

• Product realities – no one product can satisfy these days

• Production realities – Production facilities typically hard-coded to build certain

forms of a product

• Marketing resources – Marketing collateral $

So, marketers segment markets into smaller, addressable chunks where

individual buyers in any given segment share the same motivations to buy &

want the same feature set

Q: How could you segment a market?

• Buyer demographics (size, geographic location)

• Buyer psychographics (early adopter, late adopters, etc)

• Industry

• Product usage

• There is no right answer, but there are “better” answers!

SEGMENTATION STRATEGY SHOULD BE PHASED

PROFIT = (REVENUE – COST) I, S, E& REVENUE = PRICE x VOLUME

• Choose a “beach head” segment to target first

• Lowest hanging fruit

• Higher value – lower risk

• Specify “bowling pin” segments to target over the next 2-3

years

VOLUME CAN BE EXPRESSED AS A FORMULA

PROFIT = (REVENUE – COST) I, S, E& REVENUE = PRICE x VOLUME

VOLUME = BeachHeadMarket(SIZE x SHARE)

+ BowlingPinMarket(SIZE X SHARE)

Market 1

All markets

∑

SHARE = 100%

- UNINTERESTED BUYERS

– COMPETITORS % SHARE)

SUSTAINABILITY & IMPLEMENTABILITY

PROFIT = (REVENUE – COST) I, S, E

IMPLEMENTABILITY = PEOPLE (EXP & SKILLS)

+ PRODUCT

+ PROCESSES

+ PRODUCTION CAPABILITY

+ PARTNERS (SUPPLY & DISTRIBUTION)

+ PROMOTION PLAN

+ PESTs

SUSTAINABILITY & IMPLEMENTABILITY

PROFIT = (REVENUE – COST) I, S, E

SUSTAINABILITY = MARKET LIFE SPAN

+ COMPETITIVE DEFENCE

and

MARKET LIFE SPAN = TECH RATE OF CHANGE

+ RATE OF MARKET COMMODITIZATION

COMPETITIVE DEFENCE = BARRIERS TO ENTRY

+ BARRIERS TO EXIT

+ PLANNED RESPONSE TO

COMPETITIVE POSITIONING

OVER TIME

EXIT

PROFIT = (REVENUE – COST) I, S, E

• Spin Out (Promise)

• Trade Sale (Synergy)

• Dividends (Sustainability)

• Liquidation (Transferability)

WHAT WAS VAGUE, IS NOW CALCULATABLE

$ = (REVENUE – COST) ISE

= REVENUE – (P4) ISE

= ∑(PRICE x VOLUME) - (P4) ISE

= ∑(PRICE x [BHMS + BPMS] - (P4 )) ISE

= ∑(C<P<PV & P=f(CP, SP, BP) x [BHMS + BPMS]- (P4)) ISE

= ∑(C<P<PV & P=f(CP, SP, BP) x [BHM + BPMs] - (P4)) (P7) & (MLS +

CD) & (I|T|D|L)

This formula is much more complex, but now the

components are actionable & the assumptions can

be identified and justified.

Convert this math to words and there’s your

Executive Summary!

WHAT WAS VAGUE, IS NOW A CONVINCING ARGUMENT THAT CAN BE

SUMMARIZED IN 1 PAGE

∑(C<P<PV & P=f(CP, SP, BP) x [BHM + BPMs] - (P4)) (P7) & (MLS + CD) & (I|T|D|L)

• Our product is X

• 60% of our revenue comes from license fees

• At 16.99 per unit, we will sell 1.2M units in 2009

• Given market size of X for our beachhead niche and our key competitive

advantages of IP, control of distribution network, our max manufacturing

capacity of 1.2M, and general good looks our first year revenue will be 21M.

• Phased expansion across key bowling pin niches and 3 E Asian countries

as well as 40% additional revenue from S&M and Training will yield 5YR

revenue of 240M

• Profit margin is 25% given key costs in People and manufacturing

• This plan is possible given 2.5M investment for 25% equity to complete

development and support startup sales

NPV KEEPS MGMT FOCUSED ON PROFITABILITY

t - the time of the cash flow

N - the total time of the project

r - the discount rate (the rate of return that could be

earned on an investment in the financial markets with

similar risk.)

Ct - the net cash flow (the amount of cash) at time t (for

educational purposes, C0 is commonly placed to the left

of the sum to emphasize its role as the initial

investment.).

Time to make Decisions

1. Is NPV Project 1 < NPV Project 2?

2. Remember, ML has a top-down budget culture

3. Management may define incremental, fixed, flexible, zero-base,

or rolling budget assumptions

Once you submit the cost model and the business submits the revenue model for a

Project, the firm must evaluate the project against others that it could invest in.

This is done with some form of “time value of money” equation such as NPV or IRR